US malaise, debt stalemate shake allies globally

By JOE McDONALD | July 29, 2011 | 9:44 AM EDT

A man counts U.S. dollars at a currency exchange outlet in New Delhi, India, Friday, July 29, 2011. The Indian rupee ended almost flat against the U.S. dollar in a volatile trading session Thursday, weighed down by falling shares, a sluggish euro and demand for dollars from oil importers, according to news agencies. The White House and Congress are locked in a stalemate over the amount by which the U.S. debt ceiling should be raised and spending cut to help avoid a default by the world's largest economy. (AP Photo/Manish Swarup)

Many governments see Washington's paralysis as political theater ahead of a presidential election and wonder how American hardliners can be allowed to hold up a deal and bring a globalized economy to the brink.

International bankers are concerned that a U.S. default would cause a crash of the dollar, the world's reserve currency, battering economies from Asia to Africa and possibly sparking political unrest. Already, U.S. trade partners are worried about depending too heavily on one country and looking to diversify, just as China is expanding into Latin America and other markets historically dominated by the U.S.

Across the globe, allies fear that the drama between Republicans and Democrats has eroded U.S. credibility, further weakening the superpower's ability to exercise influence in the Middle East and other trouble spots.

Officials interviewed around the world said the United States at the moment is failing to lead by word, deed and example.

"You can't put your house in order being the global economic power?" Ishrat Husain, former governor of the State Bank of Pakistan, asked rhetorically. "How can you expect others to do that?"

Most officials and economic analysts who were interviewed expressed guarded optimism that American leaders would reach a last-minute agreement to raise Washington's debt limit and avoid a government default by an Aug. 2 deadline. Most took for granted that the sheer size of the world's biggest economy, together with U.S. military might and the fact that no other government is poised to take Washington's place, means it will remain a leading power for the forseeable future.

"I think nothing will shake the basis of our alliance," said a South Korean deputy defense minister, Lim Kwan-bin, when asked whether Washington's problems might weaken its 60-year military partnership with Seoul.

This week, Secretary of State Hillary Rodham Clinton tried to reassure Asian governments during a trip to the region. In Hong Kong, she said the debt debate was "messy" but was the way a democracy reaches "the right solution."

Maybe so. But still few doubted that the debt crisis is taking its toll on U.S. prestige and influence.

The showdown is playing out in a world that began to change in earnest with the U.S. financial crisis in 2008, when emerging economies such as China, Brazil and South Africa began to challenge Washington's status as the lone superpower and to assume a greater voice in global affairs.

Central banks around the world have been moving out of dollars and into other currencies, a trend that would likely accelerate if a U.S. debt crisis diminishes the status of Treasury debt, traditionally one of the lowest-risk investments.

"The turmoil we're seeing will pose the question of the (role of the) U.S. dollar in the international monetary system in a much more acute form than we've seen before," said Said Nasser Saidi, a former Lebanese trade minister and chief economist for Dubai's government-run Dubai International Financial Center.

China, the largest foreign holder of U.S. Treasury debt, has appealed for Washington to act responsibly and protect investors.

The Chinese government has stayed silent on the strategic implications of the U.S. financial struggles, perhaps because it is torn between its ambitions and economic necessity. Beijing wants Washington to reduce its military presence in Asia and has called for a global currency to replace the dollar. But China also depends on Americans to buy Chinese exports, and owns $1.1 trillion in Treasury debt, or about 8 percent of the total U.S. debt.

"China has not made any linkage (between debt and other issues) to exert pressure against the United States," said Shi Yinhong, director of the American Studies Institute at Beijing's Tsinghua University.

Nissan Motor Corp., meanwhile, unveiled an $8 billion plan this week to double annual sales in China and reduce reliance on the sluggish American market, just one of many companies shifting emphasis to fast-growing developing markets.

Mexican Treasury Secretary Ernesto Cordero said that while the United States will always be one of his country's primary economic partners, it is "simply a matter of economic common sense" that Mexico must continue diversifying its export markets. A delay in the U.S. economic recovery, he said in response to written questions, "would obviously imply that this process of diversification of Mexican exports would take place even more quickly."

Allies say it is not in anyone's interest for the U.S. economy to tumble. Anti-terror partners in Pakistan worry about the loss of badly needed aid. Protagonists of the Arab Spring foresee political paralysis. Israelis and South Koreans fear that a weakened United States will relieve pressure on North Korea and Iran to rein in their nuclear ambitions.

"It threatens the position the U.S. holds in the world," said Israeli lawmaker Danny Danon, a member of Prime Minister Benjamin Netanyahu's Likud party. If the United States "shows weakness, then it can cause other countries to take action. This can be a major issue with Iran and the terror organizations that it sponsors."

In Europe, whose financial markets are fragile after bailing out Greece, economic analysts warned that a U.S. debt default could lead to a broader crisis.

"The risk is a very big increase in the rate of interest, and to destroy parts of the banking system," said Charles de Courson, deputy chairman of the finance committee in the French National Assembly, its lower house of parliament. This could provoke "an economic crisis, and then a social crisis, and then a political crisis."

Historically, more debt means less influence in the world, de Courson added.

"The country that has been dominant begins to be less dominant, then not dominant....It was true of Great Britain after the First World War. It was the case for France after the Second World War," he said.

The United States is a major market for European companies, and cooperation with Washington on security has been a pillar of European politics since the Cold War. Following the costly U.S. wars in Iraq and Afghanistan, Europeans already are shouldering more of the expense of global policing and security, such as enforcing a no-fly zone against Libyan leader Moammar Gadhafi and carrying out air strikes against his forces.

Germany's former finance minister, Hans Eichel, says the United States "owes itself and the world" a long-term, sustainable solution to its debt problems. "The irreconciliability of the political camps, the struggle with every means against an internationally respected president, increasingly endangers the position and influence of America in every area."

Eichel served in the left-of-center government of Social Democratic Chancellor Gerhard Schroeder at a time of strained relations with Washington over the 2003 Iraq invasion. He supports U.S. efforts to control its debt, but criticized Obama's Republican opponents for opposing tax increases as too risky.

A debt default "would mean that the USA is no longer seens as a reliable economic power — fatal for the global economy, since it concerns the biggest economy on Earth," Eichel said. "And there's nothing we need more in these times of crisis more than reliability and stability."

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Associated Press writers Adam Schreck in Dubai, Nahal Toosi in Islamabad, Kristen Gelineau in Sydney, Eric Talmadge and Yuri Kageyama in Tokyo, Ian Deitch and Aron Heller in Jerusalem, Hyung-jin Kim in Seoul, Teresa Cerojano and Jim Gomez in Manila, Yinka Ibukun in Lagos, Nirmala George in New Delhi, Sameer N. Yacoub in Baghdad, David McHugh in Frankfurt and Katherine Corcoran in Mexico City contributed.